One of the most important challenges that India faces today is that of building effective state agencies. All of us have watched PFRDA, Sebi, Irda and RBI. What is the recipe for building high quality agencies in economic governance?
Why has Sebi worked well in some respects? Three ingredients have helped. The first is clarity of purpose. Sebi is a relatively young agency, created after the reforms of 1991. It was the first agency in India that saw itself as regulating a market while having no view about what the market outcome should be. Sebi is a pure regulator?it does not own or operate market infrastructure. For a comparison, RBI owns a bond exchange and depository?which gives RBI a DoT-style attitude towards competition. More importantly, RBI is a player on these markets. It is hard for an agency that is manipulating the market to have an ethos of enforcing against market manipulation. Similarly, the ministry of agriculture has controlled the Forward Markets Commission and it wants to have a say in the price of cotton and sugar. Modern economic thinking, of having a well-functioning market that discovers the price, and then respecting that price, makes the ministry of agriculture uncomfortable.
The second good ingredient in Sebi was that it was a brand new agency that carried no historical baggage. It did not have an entrenched socialist organisational culture that had to be unlearned, unlike RBI or FMC that have struggled to catch up with the new India, a market economy. It was able to do new things on the key issues of human resource policies, which has helped create high staff quality.
The third ingredient that has worked out right at Sebi is the emphasis on the rule of law. Sebi was lucky to deal with a primarily private industry, where clubby methods of addressing problems within the government were not used. So Sebi has to act against private financial firms in writing, through orders that are posted on the Web site. At its best, Sebi orders are reasoned orders, arguing from scratch what is the wrongdoing and how the law gives Sebi the power to impose a certain penalty.
The firms at the receiving end repeatedly choose to appeal at the Securities Appellate Tribunal (SAT), which has emerged as a high-quality specialised court for finance. SAT has delivered results on the three critical dimensions of speed, knowledge of finance and willingness to disagree with Sebi. Sebi does not sulk when a financial firm appeals at SAT. This is now seen as an everyday process.
Vigorous checks and balances have prevented the arbitrary exercise of power. It has helped foster an internal meritocracy within the organisation where mistakes by Sebi staff are likely to generate a painful result at SAT.
Why has RBI worked well in some respects? The first is the remarkable accomplishment of building a largely corruption-free organisation. This has been assisted by the fact that most of the financial system that RBI deals with involves PSUs, who are unlikely to offer bribes. Even then, given the extent of discretionary power (lack of rule of law) in the hands of junior RBI staff, the fact that significant corruption has not arisen is remarkable.
The second thing that has worked out right at RBI is outstanding leadership. With governors like Rangarajan and Jalan, RBI brought an intellectual capability that was an order of magnitude ahead of mainstream India. These governors created a positive public image for RBI and helped push the agency towards sensible decisions on many questions, carrying RBI into reforms even though the old guard of the agency had socialist leanings.
Why has Irda worked out badly in many respects? One key ingredient that went wrong is the location in Hyderabad. Once that decision was taken, the talent pool that Irda could access dropped sharply. In contrast, Sebi, RBI, FMC and PFRDA are able to recruit from all across India, as prospective employees are generally willing to move to Mumbai or Delhi.
A location in Mumbai is particularly useful because of the marvellous finance-related web of human capital in the city. Each employee of Sebi is surrounded by friends and family who work in the financial system. This helps bring a great deal of awareness and knowledge by osmosis into the organisation. This process was blocked off for Irda in Hyderabad, where there is no financial industry.
So what lessons can we draw from these? Financial regulation and supervision agencies should be (a) placed in Mumbai, (b) free of conflicts of interest, (c) innovate on HR practices so as to build up outstanding post-socialist people, (d) have supremely high-quality leadership, (e) have a great focus on legal process and the rule of law, and (f) work hard on control of corruption at the points of interface with private financial firms.
The author is an economist with interests in finance, pensions and macroeconomics
